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Draghi's final stimulus push keeps bond investors in suspense

Draghi's final stimulus push keeps bond investors in suspense

by Bloomberg 3 min. 13.08.2019 From our online archive
Markets are in the dark about one of the key monetary tools available to support the 19-nation economy
Expectations for quantitative easing in the euro area diverge wildly Photo: AFP
Expectations for quantitative easing in the euro area diverge wildly Photo: AFP

Mario Draghi's plans for a parting stimulus shot before he retires as European Central Bank president are laced with even more suspense than usual.

While the ECB is widely expected to cut interest rates next month, the prospect of a renewed round of asset purchases is shrouded in uncertainty. Investors must judge how much quantitative easing the euro-zone economy needs, how much buying space the central bank has before it hits self-imposed limits – and whether policy makers will dare test Draghi's claim that he can bust through those restrictions if needed.

That ambiguity means markets are in the dark about one of the key monetary tools available to support the 19-nation economy as it battles a slowdown wrought largely by external factors such as trade tensions and Brexit. Much depends on whether Draghi wants to go out with a bang before Christine Lagarde takes over on 1 November.

Most analysts predict the ECB will lower its deposit rate by 10 basis points to minus 0.5% at its 12 September meeting, joining the current wave of global easing. In the past several weeks alone, the US Federal Reserve and its peers in major economies including Russia, Australia, South Korea, Brazil, India, Indonesia and South Africa have cut rates.

Wide range

Expectations for QE in the euro area, however, diverge wildly. The market is currently pricing in around €100 billion to €200 billion of fresh stimulus, according to Alessandro Tentori, chief investment officer at Axa Investment Managers.

ABN Amro expects purchases of €70 billion a month over nine months. Morgan Stanley predicts QE at either €45 billion or €60 billion a month for at least a year. Goldman Sachs estimates that the ECB will spend as much a €300 billion.

Some analysts see bond-buying announced alongside a rate cut, while others believe there will be a delay. UBS says it doesn't consider fresh purchases a done deal.

One factor is the ECB's attempt to keep on the right side of European Union law that forbids it from directly financing governments. By restricting itself to holding no more than 33% of any nation's sovereign bonds, the institution aims to avoid becoming a dominant creditor.

The problem is that it's already at or close to that limit in some countries – including Germany, the bloc's biggest economy. In June, Draghi said there's still "considerable headroom" and that a weaker economy could warrant breaching the limits, though he's done little to clarify that view since.

Legal jeopardy

BayernLB reckons a pending ruling by Germany's constitutional court on a challenge to the legality of the programme could delay action.

"I don’t believe that a new QE programme is just around the corner," said Stefan Kipar, the bank's euro-area economist. "You have to imagine the communications disaster if they say they are doing a new round of QE, and two weeks later the Federal Constitutional Court says the Bundesbank can't participate."

QE might not even be the most useful tool for the current environment. The chief benefit of buying bonds is that it can depress longer-term borrowing costs, but investor demand for safer assets is already pushing down yields. The gap between rates on Germany's two-year and 30-year bonds is near the narrowest since the financial crisis.

"They'll change the rules if they need to," said Oliver Rakau, an economist at Oxford Economics, who predicts monthly purchases of €20 billion to be announced in September. "The question is how big of a package do you even need, and do you really need to have €60 billion that we had at times when we were still worrying about deflation? From that perspective, I think QE will be smaller, and that should also give the ECB more time to reach the boundaries."

For Axa's Tentori, a small programme would only be equivalent to a "negligible" cut in the deposit rate. Still, that doesn't mean the ECB won't act. For all the uncertainty surrounding Draghi's intentions, investors are primed for at least some kind of action.

"The markets now expect something, independent of the economic purpose," Tentori said.

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